Making the Philippines Investment Friendly for Growth and Employment: Are Labor Regulations the Binding Constraint?

Foreign direct investment (FDI) has long been acknowledged to be one of the critical inputs to developing the Philippine economy. Recognizing the potential benefits of FDI, the Government has sought to make the investment climate more hospitable by liberalizing its investment policies. However, in spite of various measures to open up more areas to foreign participation in the last twenty years, the country still lags behind its regional neighbors in terms of FDI inflows. There has in fact been a noticeable decline in FDI inflows in the last few years.

Various explanations have been advanced to account for the relatively lukewarm response of foreign investors towards the Philippines. These explanations are rather well-documented in, among others, the Doing Business (DB) site of the World Bank Group and the Global Competitiveness Report (GCR) of the World Economic Forum. In the GCR 2009-2010, the following were cited as the five most problematic factors for doing business in the Philippines: (1) corruption; (2) inefficient government bureaucracy; (3) inadequate supply of infrastructure; (4) policy instability; and (5) access to financing.

This note deals with labor regulations and how they may act as a disincentive to FDI. It is interesting that while the restrictiveness of labor regulations was also mentioned among the factors considered problematic for business, it ranked only tenth among 15 factors listed. Only 2.4 percent of respondents considered it to be among their top 5.

Nevertheless we ask the question: do labor regulations constitute a binding constraint to investment, in particular, FDI? In what follows, we specifically take a look at regulations governing the hiring and dismissal of workers and those on the practice of professions. The first is included among the variables in generating the global competitiveness index while the second is not.